Thomas Vitiello and Paul Sacks are long-time members of the Comex whose off-floor strategy has led to trading success in the electronic world. Their commodity trading advisor/commodity pool, Aurum Options Strategies, has performed well in its first two years of trading by exploiting the opportunities provided by high-frequency trading algorithms instead of fearing them as so many managers do.
“As a result of the GLD (gold exchange-traded fund), gold has become quite equitized, and because of the options listed on the GLD, there is this highly efficient, high-volume arbitrage going on between the options on Comex and options on the GLD,” Sacks says. “Thomas and I have realized that the days of being a market maker have passed and the days of becoming an intelligent market taker, taking advantage of this degree of liquidity, are the future [for] gold.”
Vitiello started working on the floor in 1983 when he was still in college, and liked it so much that he transferred to New York University from Northeastern so he could continue to work on the Comex floor. He became a member in 1987, and in 1993 started his own floor brokerage operation, filling paper for a major bank.
The rules allowed for dual trading, so he also could scalp and put on short-term trades for his own account while executing the bank’s trades.
“When you are on the floor there is an energy [that allows] you to get confirmation on all your ideas,” Vitiello says. “As the market [went] electronic, that started to dissipate. Sometimes you didn’t realize the intuition that you used had a lot to do with the flow that you saw.”
Vitiello, who serves on the Comex Board of Governors, says it was a painful lesson for many former gold locals, and by 2008 he realized he could not gain the same edge in trading gold electronically.
“As an electronic trader you realize that it turned out to be a lot more of a 50/50 game,” Vitiello says. “Before, you were in the flow inside the store; when electronic trading came in you were outside the store looking in the window without being able to hear what was going on inside.”
While in the pit, Vitiello was a scalper and short-term day trader, and he rarely carried positions overnight. “You knew the players in the pit, you knew the personalities and you are able to use your ability to analyze human behavior,” Vitiello says. He studied technicals but used them along with what he saw and heard in the pit and realized that edge left with pit trading.
While Vitiello was still floor trading, he befriended Sacks, who was making markets in gold options. Sacks, who studied finance at the University of Massachusetts — Amherst, has been a Comex member since 1997.
Unlike futures market making, options market making still remains viable. But Sacks says the writing is on the wall for options locals as well.
So the two designed a strategy based on systems Sacks had been trading that they believed would capture major upside moves in gold and mute the downside. Ironically, they say the strategy that trades gold options is not correlated to gold and targets passive gold investors who need to reduce volatility while maintaining opportunity. They aim to make strong profits and/or offset losses in large tail events in either direction. “I would characterize it as a tail risk fund. It really is an absolute return strategy,” Sacks says.
“Basically we are looking to go to someone who has $10 million in the GLD and say you would be better with $5 million in GLD and $5 million in Aurum,” Vitiello adds. He says the strategy is capable of being flat or profitable in major downturns, and capturing large upside moves. “If gold doubles, we are not going to double, we will earn several multiples. And if gold rallies 5%, on the occasions that we don’t catch it, [our clients are] still 50% passive long. In exchange for giving up some potential profit on a modest rally, they are paying us to improve both of their tail scenarios,” he says.
Sacks says they use ratio call spreads primarily over different lengths of time. “We craft it so that it is like a modified ratio butterfly; it is always in some way net long calls but we might be selling one option with one year to go and buying two options with one month to go. We are taking in the premium but we are spending it to buy extra nets. So, technically, we can’t call it a butterfly or call spread, but in essence it is a ratio calendar call spread that is always long nets and always flat premium,” he explains.
The approach has worked thus far. Aurum launched in April 2011 and earned 20.04% for the year trading managed accounts. They are up 8.61% through March this year after dropping 8.45% in 2012. Now they are preparing to launch a pool.
“It is a way for people who have been in the GLD for many years to sort of synthetically boost profits, take a little money off of the table and keep something in there to participate should something happen,” Sacks says.